Will inflation rage the longest in the UK?
The world has been fighting to shake off the most severe inflationary period for years – and the UK is particularly exposed. Why has the British economy been affected so much, and how do financial decision-makers see the country’s prospects?
We surveyed 550 senior stakeholders at companies with revenues of more than $750 million USD across the USA, UK, Germany, and Singapore. While none of these territories have been able to escape the present global economic adversity fully, the UK appeared a striking outlier in terms of the scale and severity of the challenges inflation poses to its business community.
In 2021, as the world emerged from the height of the COVID-19 pandemic, a combination of soaring demand after lockdowns eased and ongoing disruption to supply chains caused a sharp uptick in inflation1.
Russia’s invasion of Ukraine compounded this difficult situation in early 2022. Energy prices immediately soared, with oil, coal, and gas shooting up 40%, 130%, and 180%, respectively, in the first two weeks of the war alone2. Global inflation went on to hit 8.8% in 2022. Some countries found themselves, particularly in the firing line: inflation in the UK reached 9.3% in November 20223.
Inflation is not just an abstraction represented in percentages: it can have real and lasting effects on both consumers and the businesses that serve them. Higher input costs, for example, raw materials and labor, increase the cost of producing and distributing goods and reduce profit margins.
Suppliers may face difficulties in meeting their commitments due to increased costs or shortages, resulting in – at best – delays. The more complex and wide-ranging the supply chain, the more vulnerable it can be.
Demand, meanwhile, can shift rapidly as consumers reprioritize their spending in response to rising prices, while inflation can also lead to unpredictable fluctuations in exchange rates, in turn adding to costs and making managing supply chains more difficult.
The outlying UK
In our survey of senior stakeholders, 87% of decision-makers at leading British firms reported anxieties around the impact of price disruption on their activities, and 48% said they expected these problems to worsen over the next year. Overall, 47% of British leaders said they expect inflationary conditions to last more than two years, compared with 34% in Germany and 28% in the US.
At the same time, 41% of respondents identified inflation as their key concern over the previous years, with 45% saying they expected it to remain their greatest concern over the next year.
Not only was the UK most concerned with the impact of inflation in the short term, but our sample also suggests that their financial decision-makers are the most pessimistic about the years ahead. While 47% of our survey’s respondents worldwide expect inflation to cool in the next 12 months, only 35% in the UK expect to undergo the same transition.
These ongoing cost pressures are likely to be passed on to the British consumer: 40% of UK businesses reported plans to increase prices, significantly ahead of the US 33%, Germany 29%, and Singapore 28%.
These business concerns are born out when we compare the UK’s inflation rate with its international peers: as measured by the CPI (a different measure to the one quoted above), inflation in the British economy was 10.5% in the year to December 2022, compared with 5.4% in December 2021. Euro area inflation reached 9.2% in December, with France recording 6.7%. Meanwhile, in December, the USA reported inflation at 6.5%4.
The figures quoted above throw into relief the challenges inflation poses to the UK’s business leaders and policymakers. Why is the UK so acutely exposed?
Post-Ukraine energy prices are, of course, a key factor, with the UK a significant net importer of energy, and they no doubt played a role in sustaining inflation throughout 2022. However, inflation was already at 30-year highs at the beginning of 2022 – before the war began.
Global supply chain pressures took their toll as Asian manufacturing hubs struggled to keep up with demand from other markets that had emerged from lockdowns. At the same time, they remained affected by measures to contain the virus. This led to shortages in materials like plastic, concrete, steel, and timber, and in January 2022, it cost $17,000 USD to send a shipping container from Asia to Europe – compared to $1500 USD in January 20215.
This comes after the UK consumer has been relatively flush thanks to lockdown savings. During 2020 and 2021, the UK’s savings ratio shot up to thirty-year highs6; this spare cash, coupled with supply chain issues, will have played a significant role in driving up inflation.
Concurrently, whether driven by older workers declining to return to work after lockdowns or a classic wage-price spiral, a tight post-Covid labor market has added to businesses’ costs. Annual growth in average earnings rose to 6.4% in the three months to November 2022 – below inflation but a historically high rate nonetheless.
It’s also important to consider the value of the pound as a key determinant in how the UK can manage inflation.
Most commodities, including oil and gas, have their wholesale prices quoted in US dollars; a weaker pound, therefore, leads to higher import prices. In September 2022, the pound fell against most major currencies. And while it has regained some ground, as of 19 December last year, it was still 5% weaker against a basket of key currencies compared to the beginning of 20227.
A weaker pound means it costs more to import the same quantities, whether of finished goods or energy, raising business costs and contributing to the overall inflation rate. This can take effect in unpredictable ways, as many businesses set their prices in advance, and these contracts expire and must be renegotiated at times and in ways high-level data can find hard to capture.
Ongoing trade disruption from Brexit may also be a contributing factor, particularly around food prices, but it is difficult to distinguish its effects from the other factors driving up prices8.
An evolving picture
So, the UK in 2022 was particularly afflicted by inflation thanks to various interacting structural and contingent factors.
However, since we conducted our survey in November, the situation has developed, and there are green shoots that could serve as the basis for some optimism.
There are indications that global supply chain pressures are easing9, and wholesale gas and electricity prices have fallen far short of their Spring 2022 peaks10.
The Bank of England in February raised its base rate to 4%11; given the lag inherent in the effects of monetary policy, it is likely that the cost of money, at the time of writing, its highest since before the 2008 financial crisis12, will have a cooling effect on the British economy and in turn ease inflationary pressures. The Bank of England now expects inflation in the UK to fall to around 4% by the end of this year 1213, with a shallower fall in output predicted than in November of last year 1412.
However, this policy response is not without cost, with the IMF now forecasting the UK economy to contract by 0.6% this year – the only major economy expected to shrink, with even sanctions-hit Russia expected to grow more15.
This relatively poor growth forecast is just one of the issues facing British policymakers: productivity has been stagnant in the UK since 20071615, and business investment has been similarly static for more than half a decade. More recently, business investment in the UK has lagged its international peers since the height of the pandemic1716.
The outlook, then, is a forbidding one for business leaders in the UK. Officials at the Bank of England have stated that they don’t see growth of more than 1% as possible without causing inflation1817, indicating the scale of the challenges facing policymakers as they attempt to revitalize the British economy and bring inflation under control.
If and when this is achieved, decision-makers in the UK will be able to make decisions about how to manage their supply chains with greater confidence in an environment of greater stability and with a clearer picture of the landscape ahead.
It will be interesting to see if the other challenges listed by the financial decision-makers we surveyed overtake inflation over the course of 2023.
Geopolitical issues are unlikely to subside, given the lack of an end in sight for the Ukraine war and growing concerns around the status of Taiwan.
However, as we’ve mentioned, lack of inventory and supply chain issues will likely retreat as priorities. Other candidates for the main challenges that companies face include managing cash flows to maintain positive cash positions, preparing for new regulations, and developing and deploying sustainability and ESG programs.
It’s fair to say, however, that while the UK’s prospects for the rest of the year are now looking more benign than they were towards the end of last year, it is fair to say that other advanced economies do not face nearly so steep a hill to climb.
Read more of our findings from across the globe and get first access to new releases here.
4, https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/december2022; https://www.bls.gov/news.release/cpi.nr0.htm